Jamie Dimon, chief executive officer of JPMorgan Chase &
Co., stood unsmiling before a class of 300 new analysts in a
conference room at the Madison Avenue headquarters of the
firms investment banking division. The analysts stared
back in silence, seemingly confused. It was September 13, 2011.
Markets were beginning to stabilize after a volatile summer
that had seen Europes debt crisis spread to Italy and
Spain and the U.S. lose its triple-A credit rating. Occupy Wall
Street, the messy affair that would take root in lower
Manhattans Zuccotti Park, was still four days away.

You know  a bullshitter, Dimon continued.
Someone who cheats on their tax forms, who gets dinner
delivered to the office when they dont need to be there.
We all know one. First one, then two, then a small forest
of arms was raised in agreement. Yes, the analysts 
including myself, then a new JPMorgan recruit  all knew a
bullshitter. Right, Dimon continued. Now
hands up if youre a bullshitter yourself! More
silence. No hands went up. Dimon, prowling at the front of the
auditorium, did not approve. There are probably a couple
of you in here who are bullshitters. If youre a
bullshitter, you should leave now. We dont want
you.

A year later the swagger that Dimon put on display that
morning had all but disappeared. Complex derivatives trades
made in early 2012 by JPMorgans chief investment office,
supposedly to hedge risk, had racked up losses of more than
$6 billion. Two of the traders involved have since been
charged with wire fraud and conspiracy to falsify books.
Despite haranguing his trainee analysts on the evils of
deception, Dimon had apparently been blind to such behavior
within his own firm.

The reason the London Whale story was so compelling
was that here was an institution that was supposed to be the
best-operated bank on Wall Street, says Phil Angelides,
who chaired the U.S.s Financial Crisis Inquiry Commission
from 2009 to 2011. But it turned out that even the
best-managed institution on the Street couldnt monitor or
control its own exposures or even adhere to its own internal
risk parameters. Excessive risk-taking was one of the key
accelerators of the cocktail of deregulation, lax underwriting
and leverage that led to the financial crisis. But risk remains
a persistent feature of the postcrisis world. And as Jamie
Dimon can no doubt attest, it is an exceptionally difficult
beast to control.

The Legacy of Lehman: A Look at the World 5 Years After
the Financial Crisis

Five years after the collapse of Lehman Brothers Holdings
precipitated the worst financial crisis since the Great
Depression, is the world any safer? The question defies an easy
answer. Governments in the U.S. and Europe have drafted new
laws, such as the Dodd-Frank Wall Street Reform and Consumer
Protection Act, that broaden the scope of regulation to areas
such as credit default swaps and give authorities new powers to
resolve troubled institutions. Global regulators have imposed
substantially higher capital requirements on banks to
strengthen their ability to handle losses. New institutions,
such as the Financial Stability Oversight Council in the U.S.
and the Financial Policy Committee in the U.K., have been
created to monitor systemic risks and  officials hope
 nip future problems like the subprime crisis in the bud.
(See also 
The Ponzi Nation Topples)

The state of readiness to deal with threats to
systemic financial stability is far greater today than it was
in 2008, asserts Mary Miller, the U.S Treasurys
undersecretary for domestic finance, who oversees the
departments work on financial stability.

Yet the changes shouldnt leave anyone feeling
particularly safe. Consider the banking system. Western
governments spent hundreds of billions of dollars to prop up
the system with capital injections, deposit guarantees and
outright nationalizations, in some cases imperiling their own
health to do so. But today the big banks are even bigger than
before, and new, untested mechanisms designed to allow the
authorities to resolve failed banks have convinced few in the
markets that the days of bailouts are over.

Big chunks of the new regulatory infrastructure remain
incomplete. The U.S. was the source of the crisis and has been
at the heart of the response. Dodd-Frank contains the most
comprehensive suite of reforms adopted by any government,
ranging from overhauling the securitization process to bringing
over-the-counter derivatives onto clearinghouses to creating a
new consumer protection apparatus. Yet three years after
Congress enacted the law, only 40 percent of its rules have
been completed, according to Bart Chilton, who has sat on the
Commodity Futures Trading Commission since 2007. The five main
U.S. regulatory agencies charged with implementing the law were
supposed to finish the job two years ago but are still
struggling to write the myriad detailed rules required to make
it effective. Regulators by and large should have done
much better, Chilton says. (See also 
Bankers in a Bind)

In the meantime, the market is innovating in ways that may
render many of the rules obsolete. One example comes from the
swaps market. As the CFTC has strained to develop rules for
swap execution facilities  the exchangelike platforms
that are intended to bring transparency and clarity to a
previously opaque OTC market  exchanges such as CME Group
and IntercontinentalExchange have offered hybrid swap
futures products that, in broad terms, reproduce the
economic relationship of a swap at a fraction of its price.
These products promise to shift risks previously associated
with swaps into a new vehicle. Business is booming, with the
CME clearing more than 100,000 in August, up from 30,000 in
December, the month it launched the contract. Regulators are
now engaged in a mad dash to catch up, with the CFTC and the
SEC scrambling to finalize their swaps rules. (See also

New Rules, Old Risks)

Click to enlarge

The broader shadow banking system, moreover, remains a major
source of risk to financial stability. This network of lightly
regulated vehicles, including repurchase agreements and money
market mutual funds, provides the short-term funding that
lubricates the wholesale financial markets. Shadow banking
played an instrumental role in the crisis: A run by
institutional investors on short-term bank debt, mainly in the
form of repos and commercial paper, threatened to bring the
financial system down after Lehmans failure. Today the
shadow system is nearly as large as it was before the crisis,
and regulators have struggled to rein in risk. Last year the
U.S. Securities and Exchange Commission had to abandon a major
reform proposal for money market funds in the face of industry
opposition; its unclear whether the agency will succeed
in its current effort to adopt a watered-down proposal. Market
participants face a looming collateral shortfall that could
disrupt wholesale markets. And technology poses as much peril
as promise to financial institutions, judging by the latest
snafu, which shut down the Nasdaq Stock Market for several
hours in August.

The picture, critics say, is far from reassuring.
Weve preserved and in many ways made significantly
worse a very broken financial system dominated by a handful of
financial institutions that have grown too large and too
systemically significant, says Neil Barofsky, former
special inspector general for the $700 billion Troubled
Asset Relief Program and now a senior fellow at the Center on
the Administration of Criminal Law at the New York University
School of Law. And the bad incentives that were in place
prior to the crisis have been made more significant and severe.
We havent done anything to solve that  and unless
we do, were still on the pathway toward the next
crisis. (See also 
Can Finance Be Fixed?)

AS MAJOR COUNTRIES HAVE TIGHTENED capital requirements
through the Basel III accord, big banks have pushed back. If
standards are raised too high, they contend, banks will have
less capacity to make loans, causing the economy to slow and
financial risk to move into less tightly regulated entities,
such as hedge funds and clearinghouses, that make up the shadow
banking system. To date, however, theres no evidence that
raising capital has constrained lending or created new risks.
Mutual funds have provided a substantial increase in credit to
the U.S. high-yield corporate sector in recent years, says
Tobias Adrian, head of capital markets research at the Federal
Reserve Bank of New York. There is nothing inherently
unstable about this, he says. Private equity funds and
hedge funds have also stepped into the credit space more
prominently, he adds, and because these funds are generally
required by the very banks that lend to them to be well
capitalized, no single fund constitutes a systemic risk to
financial stability.

Yet shadow banking remains a primary concern of most
observers. Size explains part of the preoccupation: Although
the shadow banking system has shrunk somewhat since the crisis,
reflecting a decline in securitization, it still accounts for
nearly 40 percent of all liabilities in the U.S. financial
sector, or $14.6 trillion, according to the New York Fed
(see chart, page 52). Liabilities of commercial, federally
insured banks, by contrast, are less than
$17 trillion.